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Thunder Road report

Slowdown
Developed world imports & BRICS exports (% y-o-y)
60% 50%

40%

30%

20%

10%

0%

-10%

-20%

-30%

-40%

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Developed world imports

BRICS exports

How are they going to turn this around?

Strategy
July 2013

2013

Slowdown
Page

The correction came...and went Central banks and dysfunction in financial markets The central bank manufactured recovery is fading BRICS: broad-based slowdown US: not as good as reported Investment implications... Europe: stabilising but depressed

Japan: bright spot (for now) Inflationary Deflation: end-game update Shadow banking and collateral Gold market

46

Slide away (slides from recent corporate presentations)

51

Research: Paul Mylchreest +44 7190 7242 pmylchreest@monumentsecurities.com


This is a marketing communication. It has not been prepared under the Independent Investment research regulatory requirements and accordingly there is no prohibition on dealing ahead of the dissemination of this research material.

The correction came...and went


The equity market correction we predicted in the last Thunder Road came surprisingly quickly...as did the rebound to new highs for the S&P, which we didnt. The divergences which concerned us last time remain as wide as ever in most cases. Many commentators have highlighted the S&P 500 versus Doctor Copper or the oil price. Arguably more thought provoking is the divergence versus lumber, with housing being a notable bright spot in the US economy of late.
S&P 500 v. Lumber
1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 425 400 375 350 325 300 275 250 225 200

Source: Monument Securities

175 150 125 100 75 50 25 0

With policy makers using extreme measures to REFLATE economies and asset prices post-Lehman, it was perhaps not surprising that the S&P was closely tracking breakeven inflation from March 2009 until March 2013. Since then, the S&P 500 has powered higher while the reflationary forces have been on the wane.
S&P 500 v. 5-year breakeven inflation
1700 1600 2.50 1500 1400 1300 1200 1100 1000 900 800 0.50 700 600 0.10 0.90 1.70 2.90

Mar09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13

S&P 500

Lumber (US$)

2.10

1.30

Source: Monument Securities

The reflationary experiment is losing momentum, but not many people seem too concerned yet. The widely used model for the equity market based on the historic correlation between the ISM manufacturing survey and year-on-year percentage change in the S&P 500, continues to suggest a material over-

July 2013

Feb-09 Mar09 Apr-09 May-09 Jun-09 Jul-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jul-13

S&P 500

5-yr breakeven inflation

valuation of equities. While this models long-term track record has been impressive, it has been little help to investors since QE3 was announced last Autumn.
S&P 500 v. ISM
60.0% 67.0

40.0%

62.0

20.0%

57.0

52.0 0.0% 47.0 -20.0% 42.0

Source: ISM, Monument Securities

-40.0%

37.0

-60.0%

32.0

Sep-99

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-99

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

S&P 500 yoy %

ISM

There is a similar story with durable goods orders.


S&P 500 v. Durable Goods (ex-transportation)
1750 180000

1550 160000 1350 150000

1150

May-13
170000 140000

Source: Monument Securities

130000 950 120000 750 110000

550

100000

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

S&P 500

Durable Goods orders (ex-transportation)

While these models have their flaws (which we critiqued in the last report), the divergences are probably indicative of the increased impact of extreme monetary policies, at the expense of fundamentals, and huge associated flows of liquidity currently back from emerging to developed markets (e.g. the very recent surge in US equity inflows). In the last Thunder Road, we outlined the thesis that QE creates excess deposits in the banking system which are deployed by the banks (since they create an investment need according to JPMorgan Chase) and have a positive impact on risk assets, including equities, via collateralised transactions in the shadow banking system. Here is the (updated) intriguing correlation between the S&P 500 and excess deposits, i.e. Deposits minus Loans in US commercial banks, since September 2008 - no divergence here.

July 2013

Apr-13

Jul-03

Jul-04

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Jul-12

Oct-12

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

S&P 500 v. Deposits-Loans ("deposit to loan gap" in banking system from QE)
1800 2500

1600

2000

1400 1500 1200

Source: Monument Securities

1000 1000

800

500

600

In our End game update below, we update our analysis of the shadow banking system which remains the most identifiable source of systemic risk. Spikes in fails-to-deliver in the Treasury repo market have highlighted renewed stress in shadow banking. QE disrupts collateral flows and we question whether this is really what is behind several Fed governors desire to taper? Changes in the pattern of its asset purchases show that the Fed is acutely aware of this, as we discuss. Meanwhile, the historic separation between the physical and paper gold markets have moved to a more advanced stage. Backwardation in both the futures and lending markets is occurring with simultaneous drawdowns in the vaults, laying the ground for the next phase in the bull market.

Central banks and dysfunction in financial markets


The recent turmoil has shown that, more than ever, financial markets are at the mercy of the central banks, as theyve been thrown around violently by threats and assurances rather than changes in policy as QE3/4 continues. What happened last week based on a few words from Bernanke demonstrates the degree to which markets have become destabilized by the worlds central banks. Alhambra Investment Partners

Towering above the real economy (remember that?), a massive, mutually dependent feedback loop has been established between central bank largesse and financial markets. They have become hostages to each other in a kind of extreme two-way version of the Stockholm syndrome. Stockholm syndrome can be seen as a form of traumatic BONDing Wikipedia (my emphasis)

Systemic dysfunction is becoming slightly more apparent - for which answers/remedies are not immediately obvious. For example: Can Abenomics achieve 2% inflation? If so, will it collapse the JGB market? Is the bull market in bonds over? If so, how can massive sovereign issuance be financed (other than QE to infinity) after three decades of support from a bull market? Can the Fed REDUCE QE if US interest rates continue to rise? Is there a risk of crisis in the vast shadow banking system if it DOESNT REDUCE QE?

July 2013

Mar09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13

S&P 500

Deposits - Loans: All Commercial Banks (US$bn)

Can China deflate its massive credit bubble without causing a hard landing in the economy? Will renewed signs of structural problems in peripheral European nations eventually overwhelm the ESM/ banking system and call Draghis (thus far) OMT bluff? We suspect that new ones will materialise along the way. Theres also that other phenomenon where bad economic news causes positive market reactions based on increased likelihood of more central bank stimulus. In our (continually) unfashionable way of thinking, these sorts of issues are the natural result of policy makers actions to avoid the painful adjustment at the end of a long economic (Kondratieff) cycle, i.e. by trying ever harder to keep the credit bubble inflated. It seems almost laughable to re-read Bernankes speech on Asset Prices, Bubbles and Monetary Policy from his pre-Chairmanship days. I worry about the effects on the long-run stability and efficiency of our financial system if the Fed attempts to substitute its judgments for those of the market. Exactly. Low interest rates and monetary stimulus lead to financial bubbles and weve been maxing out on both. We are currently building the third major bubble of the last fifteen years and the lesson with the first two has been that the new bubble is larger and more dangerous than the previous one. That makes sense if you dont allow the system to fully purge previous excesses. Thank you Mr Greenspan, thank you Mr Bernanke. The asset class at the epicentre of the bubble changes NASDAQ then real estate were the first two although equities, in general, have done well each time.

S&P 500
1800

1600

1400

1200

Source: Monument Securities

1000

800

600

400

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Absent a geo-political shock, renewed signs of crisis should manifest themselves in the credit markets. The uncertainty which has recently entered the credit markets the epicentre of the current bubble was, therefore, significant. The Merrill Lynch Option Volatility Estimate (MOVE) Index measures implied volatility on 1-month options across the yield curve (2, 5, 10 and 30 year). July 2013

2013

Merrill Lynch Option Volatility Estimate (MOVE Index)


120

110

100

90

80

70

Source: BoA Merrill Lynch

60

50

40

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

The 10-year JGB yield is stabilising near its recent high. Capped?
JGB 10-year yield (%)
1.00

0.90

0.80

0.70

May-13

Jul-13

Source: Monument Securities

0.60

0.50

0.40

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

And lets not forget the recent whipsaw move in SHIBOR.


SHIBOR O/N (%)
9.00

8.00

7.00

6.00

5.00

May-13

Jul-13

Source: Monument Securities

4.00

3.00

2.00

1.00

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

July 2013

May-13

Jul-13

The first two bubbles (NASDAQ and real estate) were allowed to burst of their own accord. The Feds current plan to begin withdrawing QE later this year is a threat to act in a pre-emptive way and slow the formation of the current bubble a departure from its previous laissez-faire policy. Consider this quote from Bernanke in that same speech Asset Prices, Bubbles and Monetary Policy. I will discuss below why I believe that, nevertheless, leaning against the bubble is unlikely to be productive in practice And compare it with this comment from the Q&A on 10 July 2013 when he indicated that his recent postFOMC comments had deliberately targeted risk-taking behaviour. where we dont provide any information, its very likely that more highly levered, risk-taking positions might build up, reflecting, again, some expectation of an infinite... infinite asset purchase programme. Why the apparent change? You have to wonder whether the current bubble was becoming a bit too obvious (and embarrassing) even for the Fed! (Bernanke is) running the most inappropriate monetary policy in history. And in a rare moment of central banker tell it like it is... Lets be clear. Weve intentionally blown the biggest government bond bubble in history. We need to be vigilant to the consequences of that bubble deflating more quickly than (we) might otherwise have wanted. Andrew Haldane, Bank of England Hedge fund legend, Stanley Druckenmiller

If preventing the creation of financial bubbles played a part, the Fed has got religion too late in the day. Things are so fragile that, having issued a threat of reduced stimulus, Bernanke and his Fed colleagues were forced to follow up with assurances of continued stimulus almost immediately. This is starting to damage their credibility, belatedly, even with the mainstream. While bubbles burst, theres still a lot of water to flow under the proverbial bridge yet.

July 2013

The central bank manufactured recovery is fading


Central bank stimulus...Lots of it? Even more? Slightly less? Whatever it takes?...is attempting to keep asset prices elevated, and unwelcome price signals sufficiently distorted, until the holy grail of self-sustaining economic recovery takes hold. Its nearly five years since Lehman and the consensus view remains optimistic on this issue. The problem is that this central bank-manufactured reflation of the global economy is showing signs of running out of steam. Indeed, we appear to be in a dangerous treading water kind of stage and recent events in China and the other BRICS, rising interest rates, etc, are hardly bullish.
Global Industrial production growth % yoy (since 2009)
15.0%

10.0%

5.0%

0.0%

Source: Monument Securities

-5.0%

-10.0%

-15.0%

Sep-09

Sep-10

Sep-11

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-09

Jul-10

Jul-11

Jul-12

May-09

May-10

May-11

How are they going to turn this around? Just when momentum in the global economy appears to be fading, the Chinese are trying to cool excessive credit growth and the Fed is preparing to cut back QE. Xinhua relayed an interesting quote from Chinas Finance Minister, Lou Jiwei, at the G-20 meeting in Moscow. Some developed countries appear to be overly optimistic about the economic outlook. The most recent data suggests that world trade is subdued...not a good sign. For example, container throughput in major Asian shipping hubs remains fairly weak.
Singapore: Container throughput (yoy %)
25.0% 20.0%

May-12

Mar-13

Jan-09

Jan-10

Jan-11

Jan-12

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

Source: MaPA of Singapore, Monument Securities

15.0%

10.0%

5.0%

0.0%

-5.0%

-10.0%

-15.0%

-20.0%

-25.0%

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

July 2013

May-13

Moreover, if we aggregate exports of the BRICS nations (including South Africa), year-on-year growth moved back into negative territory in May.
BRICS exports (% y-o-y)
60% 50%

40%

30%

20%

10%

Source: Monument Securities

0%

-10%

-20%

-30%

-40%

Apr-99

Apr-04

Sep-99

Feb-00

Sep-04

Feb-05

Apr-09

Sep-09

Feb-10

Jun-98

Jun-03

Jun-08

Jul-00

Jul-05

Mar-02

Mar-07

Jul-10

Mar-12

Dec-00

Dec-05

Dec-10

Oct-01

Oct-06

Aug-02

Aug-07

Oct-11

Aug-12

Jan-98

Jan-03

Jan-08

Nov-98

Nov-03

May-01

May-06

Nov-08

Imports into developed nations US, Eurozone, Japan & UK in the chart below are slightly negative.
Developed world imports (% y-o-y)
30%

20%

10%

0%

-10%

May-11

Jan-13 Nov-12 Apr-13

Source: Monument Securities

-20%

-30%

-40%

Apr-98

Apr-03

Sep-98

Feb-99

Sep-03

Feb-04

Apr-08

Sep-08

Feb-09

Jun-97

Jun-02

Jun-07

Mar-01

Mar-06

Mar-11

Dec-99

Dec-04

Dec-09

Oct-00

Oct-05

Aug-01

Aug-06

Oct-10

Aug-11

Nov-97

Nov-02

May-00

May-05

Nov-07

Developed countries arent importing and emerging nations arent exporting and the S&P is making new highs. The biggest near-term delta on global growth is likely to be China, which is deliberately trying to deflate its own credit bubble, and the other BRICS. This was our economist, Stephen Lewis, last week: Last year, China accounted for 11.5% of global GDP but its direct contribution to global GDP growth was as much as 40%. This probably under-estimates the impact of Chinas economic activity on the world as a whole. International trade with China, through multiplier effects on demand in Chinas trading partners, almost certainly exerts an indirect influence boosting global growth. If the impetus behind Chinas expansion were to flag, the implications for economic conditions in the rest of the world would be serious indeed. Lets not forget that Chinas turbo stimulus back in 2009 was a primary driver behind the global econJuly 2013

10

May-10

Jun-12

Jul-99

Jul-04

Jan-97

Jan-02

Jan-07

Jul-09

Jan-12

omys resurgence. Total loans made by Chinese financial institutions reached annualised growth rates of almost 35% during 2009.
China: total loans of financial institutions (yoy %)
35

30

25

Source: Monument Securities

20

15

10

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

...the greatest misallocation of capital the world has ever seen, which was Chinas 2009 stimulus. Paul Krake of View from the Peak

Given the clampdown on credit growth, its logical to assume a further slowdown in the coming months. We thought that the authorities would allow the credit gowth to continue for longer, hence our lousy long on the bombed-out Shanghai Composite. Estimating Chinas actual rate of GDP growth BEFORE any near-term slowdown is impossible. If electricity production is any kind of indicator, growth might have already slowed to about 5%.
China: Electricity production v. GDP growth
25% 13%

20%

15% 10% 10% 9% 5% 8%

Apr-13
12% 11% 7% 6%

Jul-03

Jul-04

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Jul-12

Oct-12

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Source: Monument Securities

0%

-5%

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

Electricity production (yoy %)

GDP growth (yoy %)

The June 2013 report on Chinese exports showing a 3.1% year-on-year decline took markets by surprise. The correlation between Chinese exports and the global manufacturing PMI does not augur well.

July 2013

11

Apr-13

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Oct-05

Oct-06

Oct-07

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Oct-11

Jul-12

Oct-12

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

China export growth v. global manufacturing PMI


60 70

50

65

40

60

Source: Markit.com, Monument Securities

30 55 20 50 10 45 0 40

-10

-20

35

-30

30

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

China exports (yoy %)

Global manufacturing PMI

The BRICS were already experiencing a broad-based slowdown before the Chinese credit squeeze. An unintended consequence of the Feds tapering comments has dealt another blow to these nations. Dollar strength is hitting countries with current account deficits especially hard, i.e. Brazil, India and South Africa.
BRICS: Current account balance (% of GDP)
20

15

10

May-13

Source: Monument Securities

-5

-10

CAPITAL IS FLEEING, currencies are weak and interest rates have soared. South Africa, for example.
South Africa: 10-year government bond yield (%)
8.50

8.00

7.50

7.00

Q1 2000 Q2 2000 Q3 2000 Q4 2000 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Q1 2003 Q2 2003 Q3 2003 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013
China India Brazil Russia South Africa 6.50 6.00 5.50

Source: Monument Securities

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

July 2013

12

May-13

Jul-13

We are going to see the impact of this fairly soon. In the last Thunder Road, we highlighted complaints from the BRICS nations about the risk of a currency war resulting from loose monetary policies of developed nations. The tapering debate and the sudden strength in the dollar have turned this situation on its head. What is clear is that the BRICS are becoming increasingly annoyed with being on the receiving end of the VARIABILITY in G7 monetary policy and the instability it is causing. This is the rollercoaster ride of Brazils Real during the last five years.
Brazilian Real spot
2.60

2.40

2.20

2.00

Source: Monument Securities

1.80

1.60

1.40

Brazils President, Dilma Rousseff, met Chinas Xi Jinping on 24 June 2013 after the FOMC meeting. According to Reuters: Brazilian President Dilma Rousseff and her Chinese counterpart, Xi Jinping, discussed ways to strengthen policy coordination on Monday in a telephone conversation, said Thomas Traumann, spokesman for the Brazilian government. Rousseff will contact other leaders of the BRICS group, which include Russia, India and South Africa, later this week to discuss concrete measures. The BRICS will decide on coordinated action related to the global appreciation of the U.S. dollar at a meeting in July in Russia, Traumann said without elaborating. Before last weeks G20 meeting of finance ministers, Russias Anton Siluanov did little to hide his criticism of the US. From CNBC: I think everyone will be against any sudden changes in currency exchange rates and monetary policies, Finance Minister Anton Siluanov told Reuters in an interview. Any tightening of monetary policy, such as the withdrawal of quantitative easing, should be done in a predictable and consistent manner, he added. We (the G20) should not create reasons for instability, Siluanov said. The policy of countries issuing reserve currencies should be predictable. We keep emphasising the significance of the BRICS meeting in March 2012, when the BRICS made it their policy to increase trade in local currencies. China has led the way, setting up bilateral currency swaps with almost all of its major trading partners. More than 15% of its external trade is now settled in Yuan. The BRICS are in the early stages of the dismantling of the dollars monopoly on world trade.

July 2013

Jul-08 Sep-08 Oct-08 Nov-09 Dec-08 Jan-09 Feb-09 Mar09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13

13

Meanwhile, its clear that tensions are rising between the BRICS and G7, especially the US. This is worrying given the fragile state of the global economy. We are not there yet...we might not get there...but there is increased RISK OF A FULL-BLOWN CURRENCY CRISIS HITTING THE BRICS, beginning with India, Brazil and South Africa. India looks particularly vulnerable. If this unfolds, it would almost certainly lead to a stand-off between the BRICS and the US. In an extreme case, the former could try to support their currencies with their vast (mainly US$) forex reserves.
BRICS foreign exchange reserves (US$ bn)
5000 4500

4000

3500

3000

2500

Source: Monument Securities

2000

1500

1000

500

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

India has done a modest amount so far.


India: foreign exchange reserves v. Rupee spot
330 40

320 45

310

300 50 290

280 55 270

May-13
60 65

Source: Monument Securities

260

250

240

Weve mentioned China, but what about conditions in other BRICS? India raised its Marginal Standing Rate by a huge 200bp (panic?) from 8.25% to 10.25% last week to support the Rupee...and fight its inflation problem.

July 2013

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

Foreign exchange reserves (US$ bn)

Rupee/US$ (Inverted)

14

ning at c. 0.88m bpd in 2013, i.e. an import ratio of 77%. Industrial production growth is negative.

...which will probably get worse in the coming months given the recent crude price rise. OPEC estimates

that Indias crude oil demand is running at approximately 3.80m bpd versus domestic oil production run-

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
10 12 14 16 18 0 2 4 6 8

-10 10 15 20 25 -5 0 5

0%

-20% 70%

-10%

10%

20%

30%

40%

50%

60%

Jan-01 Jun-06 Aug-06 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 May-01

Apr-06

Jan-01

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

Growth in domestic vehicle sales has vanished.

May-05

Sep-05

Jan-06

May-06

Sep-06

India CPI (yoy %, Industrial workers)

India: Industrial production (yoy %)

India: Domestic vehicle sales (yoy %)

15

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

May-13

The Composite Leading Indicator for India is lower than it was in the 2008 crisis although it has turned up

Source: OECD

Source: Monument Securities

Source: Monument Securities

July 2013
100 101 102 103 97 98 99
11000 13000 15000 17000 19000 21000 23000 7000 9000

1000

1200

1400

very modestly since the March low.

200

400

600

800

Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

Sensex

India: OECD Composite Leading Indicator

The Sensex has held up relatively well so far, but would be surprising if it lasts.

It will be worth keeping an eye on the share prices of Indias major banks, like ICICI:

ICICI Bank

16

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13 Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

The latest manufacturing PMI for June was unchanged at 50.4 we are stuck at the low point for 2013.

Brazil raised its key policy rate by 0.5% (to 8.5%) for the second time in two months to combat inflation.

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
10 15 20 25 30 0 5
0% -40% 20% 40% 60% 80% -20%

Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Jan-02 Sep-01 May-01

Jan-01

100

105

110

115

120

125

130

90

95

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Consumer confidence has seen renewed weakness.

Jan-09

Mar-09

Selic

Brazil: Selic target rate v. CPI (%)

Brazil: Consumer confidence

Brazil: Iron ore exports (yoy % 3m MA)

Markit reported that new orders continued to deteriorate. Iron ore exports are still declining.

17

May-09

Jul-09

Sep-09

CPI

Nov-09

Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13
2 4 6 8 10 12 14 16 18

Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
100 110 120 50 60 70 80 90

10.0

30000

35000

40000

45000

50000

55000

60000

65000

70000

75000

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Jan-10 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

Jan-01

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

The Bovespa index has broken lower.

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

In Russia, inflation is well above first half 2012 levels.

Aug-11

Bovespa

Russia: CPI (yoy %)

Brazil: Retail sales volume

The strong growth in retail sales during the last decade has levelled off.

18

Sep-11

Oct-11

Nov-11

Dec-11

Jan-12

Feb-12

Mar-12

Apr-12

May-12

Jun-12

Jul-12

Aug-12

Sep-12

Oct-12

Nov-12

Dec-12

Jan-13

Feb-13

Mar-13

Apr-13

May-13

Jun-13

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
-20 -15 -10 20 10 15 -5 0 5 100 -60 -40 -20 20 40 60 80 0

-15

-10

10

15

-5

Jan-01 Apr-07 Jun-07 Aug-07 Oct-07 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Jul-06 May-06 Mar-06 Jan-06

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

Auto sales are very weak, reminiscent of India.

May-05

Sep-05

Jan-06

May-06

Retail sales growth in real terms has been slowing sharply.

Russia: Car sales (yoy %)

Russian industrial production growth is hovering either side of zero.

Russia: Real retail sales (yoy %)

Russia: Industrial production (yoy %)

19

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

May-13

So we have a broad-based slowdown in the BRICS, which has some way to run.

The US - not as good as reported


With US GDP growth in the first half of 2013 likely to prove so disappointing (c.1.0%), markets are placing great store in a second half recovery...and a further acceleration in 2014. Any chance that optimism could be misplaced? Yes, especially if you buy into the slowing global growth picture. The next chart shows just how in synch prospects for the US economy have been with the global economy since 2001 - as China emerged as an economic force.

Global manufacturing PMI v. ISM manufacturing


65.0

60.0

Source: Markit.com, Monument Securities

55.0

50.0

45.0

40.0

35.0

30.0

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

Global manufacturing PMI

ISM manufacturing

While the trends remain closely correlated, even the relative growth rates of global and US industrial production have converged in recent times.
Industrial production growth: global v. US (yoy %)
15%

10%

5%

0%

May-13

Source: Monument Securities

-5%

-10%

-15%

-20%

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

Global industrial production (yoy %)

US industrial production (yoy %)

July 2013

20

May-12

Jan-13

The critical upshot of all this taper-on, taper-off talk and unwinding of leveraged trades during May and June is exactly NOT what we needed in the middle of the biggest debt crisis in history.
Benchmark US 10-year Treasury yield
2.80

2.60

2.40

2.20

2.00

Source: Monument Securities

1.80

1.60

1.40

1.20

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

Lets just remind ourselves of the debt load being carried by the US economy now approaching US$60 trillion and its trajectory.
US Total credit market debt since 1960 (US$ trn)
60

50

40

30

May-13

Jul-13

Source: Federal Reserve

20

10

There is spectacular irony in the danger from rising interest rates with respect to Bernanke... Before being appointed Fed Chairman, he gave several speeches on combating deflation. Among them is Money, Gold and the Great Depression from 2 March 2004. In this speech, Bernanke recounted a series of policy mistakes which led to the Great Depression and, subsequently, contributed to its severity. Each mistake Bernanke highlighted during 1928-33 involved a tightening of monetary policy, exactly as the Fed has proposed recently. However, the real irony is the manner in which the Fed tightened monetary policy in 1932 via the reversal of open-market operations - basically reducing QE! The open-market operations had pushed down rates on government bonds and corporate debt which started to rise. According to Bernanke:

July 2013

Q1 1960 Q1 1961 Q1 1962 Q1 1963 Q1 1964 Q1 1965 Q1 1966 Q1 1967 Q1 1968 Q1 1969 Q1 1970 Q1 1971 Q1 1972 Q1 1973 Q1 1974 Q1 1975 Q1 1976 Q1 1977 Q1 1978 Q1 1979 Q1 1980 Q1 1981 Q1 1982 Q1 1983 Q1 1984 Q1 1985 Q1 1986 Q1 1987 Q1 1988 Q1 1989 Q1 1990 Q1 1991 Q1 1992 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013

21

These policy makers did not appear to appreciate that, even though nominal interest rates were very low, the ongoing deflation meant that the real cost of borrowing was very high because any loans would have to be repaid in dollars of much greater value. Here is the recent trend in real interest rates in the US, based on the benchmark 10-year:
Barclays US Inflation linked 7-10 years real yield (%)
0.60

0.40

0.20

0.00

-0.20

Source: Monument Securities

-0.40

-0.60

-0.80

-1.00

-1.20

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

Rising real rates combined with so much debt is a potent force which could prematurely burst the credit bubble. BERNANKE HAS TIGHTENED POLICY WITHOUT DOING A THING. He has effectively achieved a reverse Draghi. Meanwhile, lets consider the current strength of the US economy in terms of purchasing manager surveys, jobs, housing, etc. Ironically, when QE3 was announced on 13 September 2012, the latest reported figure for the ISM manufacturing survey was 50.7, for August 2012. When the FOMC announced its intention to taper, the latest ISM manufacturing number was even lower at 49.0 (May 2013) and signifying contraction. Since then, the June 2013 number was reported at 50.9, basically unchanged versus the QE3 announcement. The Non-manufacturing ISM has been on a downward trend for four months and is 2.1 points lower than when QE3 was announced.
US ISM Non-manufacturing index
60

55

50

May-13

Jul-13

Source: ISM, Monument Securities

45

40

35

Sep-08

Sep-09

Sep-10

Sep-11

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

July 2013

22

May-13

The broadly based (85 monthly indicators) Chicago Fed National Activity Index is also very close to the level when QE3 was announced last Autumn.
Chicago Fed National Activity Index (3m MA)
1.00

0.00

Source: Chicafo Fed, Monument Securities

-1.00

-2.00

-3.00

-4.00

-5.00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

The obvious push-back on prospects for the US economy is the latest better-than-expected nonfarm payrolls (NFPs) number of 195,000 for June, with upward revisions to the prior two months. The unemployment rate (U3) actually ticked up 0.1% to 7.6% from the April low. If we go back to the announcement of QE3, August 2012s U3 unemployment reading was 8.1%, so weve seen all of a 0.5% reduction. Thanks to work by Zero Hedge, there are justifiable grounds for questioning the recent positive NFP data. Besides the NFP survey, there is an alternative survey of US jobs creation, which is also published by the Bureau of Labor Statistics. This is the JOLTS survey, or Job Openings and Labour Turnover Survey, which gets little recognition because the data for any given month is published a month after the NFP. The net increase or decrease in US jobs is the difference between the data for Hires and Separations. The chart shows the VERY close correlation between the net monthly figure based on JOLTS and NFP since 2001.
US monthly jobs: JOLTS v. Nonfarm payrolls (000s)
600

400

200

-200

May-13

Source: Monument Securities

-400

-600

-800

-1000

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

JOLTS

Nonfarm Payrolls

July 2013

23

May-13

If you look on the very right hand side of the chart and the data for the most recent months, you can see some greater-than-usual divergence in the data. While we await the JOLTS data for June 2013, lets consider the data for the six months from December 2012-May 2013 and compare the two.
US monthly jobs: JOLTS v. Nonfarm payrolls (000s)
350

300

250

200

Source: Monument Securities

150

100

50

0 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13

JOLTS

Nonfarm payrolls

For the last two months, the JOLTS data implied net job creation of 108,000 and 118,000 compared with 195,000 and 195,000 for NFP, i.e. lower by 45% and 39%, respectively. How interesting that the divergence has widened post-QE3 as the Fed has increasingly attempted to establish the (tenuous) link between QE and employment. If you needed confirmation about the validity, or lack thereof, of the NFP numbers, there was the comment by the former head (2008-12) of the Bureau of Labor Statistics, Keith Hall, in the New York Post on 19 July 2013. Right now (its) misleadingly low, says Hall, who believes a truer reading of those now wanting a job but without one to be more than 10 percent. Back to JOLTS and the data for Hires. The year-on-year trend is clearly suggestive of a slowdown and has moved into negative territory.
JOLTS Hires (yoy %)
20%

15%

10%

5%

0%

Source: Monument Securities

-5%

-10%

-15%

-20%

-25%

Apr-02

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

The latest figure for the broader (and more realistic) U6 unemployment rate actually spiked 0.5% to 14.3%. The improvement in this measure since August 2012 is an even more modest 0.4%.

July 2013

24

Apr-13

Jul-02

Jul-03

Jul-04

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Oct-02

Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Jul-12

Oct-12

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

The suspicion that the labour market is weaker than advertised fits with the downwards trend in personal

The BLSs figure for the ratio of civilian employment/population is UNCHANGED AT 58.7% SINCE QE3 was

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
55 8 9 56 57 58 59 60 61 62 63 64 10 11 12 13 14 15 16 17 18 6.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Sep-09 Jul-09 May-09 Mar-09 Jan-09 Nov-08 Sep-08 Jul-08 May-08 Mar-08

Jan-08

Jan-08

Mar-08

May-08

consumption expenditures.

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

US unemployment rate U6 (%)

US employment / population ratio (%)

US: Personal consumption expenditure (yoy %)

announced and has basically remained flat throughout the post-Lehman period.

25

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

The bright spots in the US economy are obviously housing and the auto market (another sub-prime issue in the making?). After a brief correction, the NAHB market index continues to rise spiking from 51 to 57 this month. In contrast, share prices of major US house builders, like Lennar and DH Horton, have underperformed recently.
NAHB survey v. Lennar price relative
80 6.00

70 5.00 60 4.00 50

Source: NAHB, Monument Securities.

40

3.00

30 2.00 20 1.00 10

0.00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

NAHB survey

Lennar price relative

Housing starts were unexpectedly weak in June 836,000 was well below the 911,000 housing permits so it could be a statistical anomaly in part.

US: housing starts v building permits (000s)


2400

2000

1600

May-13

Source: Monument Securities

1200

800

400

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

Housing starts

Building permits

July 2013

26

May-13

The Case-Shiller data shows house prices on a rising trend, although we only have figures up to April 2013 (+11.9% versus year ago). The recent correction in the MBA Purchase Index, due to higher mortgage rates, suggests that it could have stalled recently.
Mortgage Purchase index v. Case-Shiller House Price Index
550 230

500 210 450

400

190

Source: MBA, Monument Securities.

350 170 300

250

150

200 130 150

100

110

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

MBA Mortgage Purchase Index

Case-Shiller Home Price Index SA

It could be 2-3 months before we get an accurate fix on the trend in US housing. The growth rate in US auto sales remains healthy although it looks set to level off later this year as the absolute level of sales (on an annualised basis) has been flat since late-2012. Overall, we have our doubts as to whether the US economy has reached escape velocity in terms of selfsustaining growth. Look at the chart of the ISM manufacturing survey below. While the trend is clear, Ive annotated it with the major central bank interventions (or threatened intervention with respect to the ECBs OMT) which led to the reversal in each case: A. QE1 B. Anticipation of QE2 C. Operation Twist D. Draghi moment followed by anticipation of QE3 Two observations: The Federal Reserve (with support from other central banks at times) has implemented a NEW STIMULUS PROGRAMME about once every 12 months; and Look how closely the first four stimulus programmes coincided with either the absolute low (end-2008) for this index, or were close to the lows in 2010, 2011 and 2012.

July 2013

27

May-13

ISM manufacturing index & central bank interventions


65

60

55

B C
Source: ISM, Monument Securities

50

45

40

35

30

A
Sep-08 Sep-09 Sep-10 Sep-11 Mar-09 Mar-10 Mar-11 Mar-12 Sep-12 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 May-09 May-10 May-11 May-12 Mar-13 Jan-09 Jan-10 Jan-11 Jan-12 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Jan-13 May-13

With the ISM currently at a relatively weak level, The Feds desire to taper flies in the face of our experience since Lehman. More so, when the deflationary (or disinflationary) forces appear to be relatively strong currently. In our way of thinking, a battle royal is playing out between: The increasingly powerful deflationary forces of too much debt, negative demographics, misallocated capital, etc, which act to slow growth and reduce prices; and The inflationary (or reflationary) push-back of central banks which acts to stimulate growth and raise the prices of goods & services and assets. While we expect inflation to triumph in the end, there is constant friction between the deflationary and inflation forces and it appears that the strength of the former are easily underestimated. Look at the problems Japan is having in creating inflation! Below is the chart for long-term inflation expectations in the US based on the 10-year breakeven, together with the four major stimulus programmes.
US 10-yr breakeven & central bank interventions
3.00

2.50

2.00

D B C
Source: Monument Securities

1.50

1.00

0.50

0.00

A
Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Mar09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 Jun10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13

Hmmmm. Notice the recent upward blip which has corresponded with the more dovish (on tapering) comJuly 2013

28

ments from Bernanke and his Fed colleagues. Besides breakeven inflation, other indicators are also suggesting that the deflationary forces (or disinflationary forces, at least) are little changed, or have even strengthened, since the Fed first announced QE on 13 September 2012. Prior to QE, the CPI reading was 1.7% - for August 2012. This compares with the latest figure of 1.8% for June 2013 both being below the Feds 2.0% longer run target.
US CPI (%)
6.0

5.0

4.0

3.0

2.0

Source: Monument Securities

1.0

0.0

-1.0

-2.0

-3.0

Sep-08

Sep-09

Sep-10

Sep-11

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-09

May-10

May-11

May-12

Mar-13

Jan-09

Jan-10

Jan-11

Jan-12

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

And Bernankes aversion to deflation is almost legendary, e.g. his famous speech Deflation: Making Sure It Doesnt Happen Here, a.k.a. the helicopter speech. US import prices, which have a fairly close correlation with CPI, are flat year-on-year.

US: CPI v. import prices (yoy %)


6.0 25.0 20.0 15.0 10.0 5.0 2.0 0.0 1.0 -5.0 0.0 -10.0 -15.0 -20.0 -25.0

5.0

4.0

3.0

May-13

Source: Monument Securities

-1.0

-2.0

-3.0

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

CPI

Import prices

July 2013

29

May-13

Similarly, prices of used cars are also lower year-on-year - and often lead the CPI.
US: CPI v. Used car prices (yoy %)
6.0 20.0

5.0

15.0

4.0

10.0

3.0 5.0 2.0 0.0 1.0 -5.0 0.0 -10.0

Source: Manheim, Monument Securities

-1.0

-2.0

-15.0

-3.0

-20.0

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

CPI

Manheim Used Vehicle Value Index

Although we have to keep our eye on the all-important gasoline price.


US gasoline contract (NYMEX)
400

350

300

250

200

May-13

Source: Monument Securities

150

100

50

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

Investment implications...
Lets recap and try to decipher what it might mean from an investment perspective. The central bank manufactured reflation of the global economy since Lehman is running out of steam. The market seems reluctant to acknowledge this right now, even though its far from clear what could turn it around. The BRICS nations are at the leading edge of the slowdown in the cycle, which is highly significant since they have been relied upon to be the primary driver of global expansion. There is the potential for a fullyfledged crisis in one or more of the BRICS, although we have to assume that this is a tail risk currently. Despite holding up reasonably well, the US economy is probably weaker than consensus expectations suggest. It is also likely to be impacted by slowing growth in the rest of the world. July 2013

30

May-13

Jul-13

Well discuss Europe and Japan later, but the former is unlikely to recover from recession during the rest of this year. Incipient recovery in Japan is unlikely to offset the weakening trend elsewhere and could still stall. With economies (including the US and China) carrying so much debt, the recent spike in rates (nominal AND real) should act as a further drag on growth. With policy rates already close to zero and the Fed already running at US$85bn per month of QE, central banks (with the exception of the BoJ) dont have the appetite for significant additional stimulus. However, Bernanke cant afford to let rates rise much further than their recent highs. He implied as much in the Q&A after his speech (commemorating 100 years of the FED) on 10 July 2013. And I guess the final thing I would say in terms of risks of course is that we have seen some tightening of financial conditions, and that if, as Ive said and as I said in my press conference and other places that if financial conditions were to tighten to the extent that they jeopardize the achievement of our inflation and employment objectives then we would have to push back against that. Absent wholesale dumping of foreign assets by BRICS nations in a currency crisis, interest rates are probably capped at levels not much above their recent highs for the time being. With the slowdown in global growth, tapering (even if it begins in September) is likely to be modest and/or temporary. What does this mean for equities? A slowdown in global growth is clearly NOT going to be a positive environment for equities... However, while the message for equities is cautious, there is the elusive question of TIMING. A good indicator on equity market timing during the last 12 months has been the Summation Index. This is a measure of market breadth, being a running total of Advance minus Decline values of the McClellan Oscillator. It is currently recovering along with the S&P 500, but the next rollover could be significant.
S&P 500 v. Summation Index
1700 5000 4500 4000 1600 3500 1550 3000 2500 2000 1500 1400 1000 1350 500 0

1650

Source: McClellan, Monument Securities

1500

1450

1300

S&P 500

Summation Index

July 2013

31

19/07/2013 22/07/2013

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

May-13

Jul-13

In the last report, we started road testing our own directional model for the equity market, since so many other models seemed to be failing at the time. We christened it Club 18-13 since it consists of 13 medium/long-term cycles (41 months and above) and an additional 5 short-term cycles, making 18 in all. Instead of being based on economic variables, it is based on aggregating cycles of varying TIME lengths in the equity market. Using monthly data, the 13 cycles have picked out most of the peaks and troughs in US equities since 1905 (although it was early on the NASDAQ peak).
Dow Jones Industrial Average: actual v. predicted trend 1905-2013
2.75 2.50 1.06 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.96 0.25 0.00 0.94 0.98 1.02 1.08

1.04

Source: Monument Securities

1.00

1910

1915

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Actual

Predicted

It is early days still and we fully accept that we might fall flat on our face. However, using weekly data since 2009, and all 18 cycles, the model managed to predict the correction from late-May to late-June. It certainly missed the recent resurgence in equities, although the most interesting thing for me is the prediction of a more sustained decline beginning this Autumn...well see.
Dow Jones Industrial Average: actual versus predicted 2009-13
1.40 1.015 1.30 1.010

1.20

2010
1.005 1.000 0.995 0.990

1.10

1.00

0.90

Source: Monument Securities

0.80

0.985

0.70

0.980

0.60

0.975

0.50

0.970

2009-01-02

2009-03-02

2009-05-02

2009-07-02

2009-09-02

2009-11-02

2010-01-02

2010-03-02

2010-05-02

2010-07-02

2010-09-02

2010-11-02

2011-01-02

2011-03-02

2011-05-02

2011-07-02

2011-09-02

2011-11-02

2012-01-02

2012-03-02

2012-05-02

2012-07-02

2012-09-02

2012-11-02

2013-01-02

2013-03-02

2013-05-02

2013-07-02

2013-09-02

2013-11-02

Actual

Predicted

July 2013

32

2014-01-02

Stay defensive... With global growth slowing, there is an increasingly strong argument for getting off the cycle to a greater extent, in terms of exposure in equity portfolios. In the UK large cap universe, besides Randgold and Fresnillo (for precious metals advocates like us), this basically means the pharmaceutical stocks. Here the choice is between the pricey Shire Pharmaceuticals, the stumbling (?) Astra Zeneca, or perhaps the more solid GlaxoSmithKline (returning to positive top line growth).
GlaxoSmithKline price relative to UK All-Share Index
0.65

0.60

0.55

Source: Monument Securities

0.50

0.45

0.40

0.35

Much as I hate to say it (being an end game Inflationista and gold advocate), bonds could become interesting (temporarily) as growth slows and central banks push back against any further rise in rates, if necessary. Declining bond yields would provide something of a tailwind for some of the bond proxies, like the big consumer staples stocks. The S&P 500 Consumer Staples index has underperformed recently, although it has decoupled from the full extent of the move in yields.
Consumer Staples price relative v. 10 yr US Treasury Yield
0.28 1.20

0.27

0.27

0.26

0.26

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13
1.40 1.60 1.80 2.00

Source: Monument Securities

0.25

2.20

0.25

2.40

0.24

2.60

0.24

2.80

03/01/2012

17/01/2012

31/01/2012

14/02/2012

28/02/2012

13/03/2012

27/03/2012

10/04/2012

24/04/2012

08/05/2012

22/05/2012

05/06/2012

19/06/2012

03/07/2012

17/07/2012

31/07/2012

14/08/2012

28/08/2012

11/09/2012

25/09/2012

09/10/2012

23/10/2012

06/11/2012

20/11/2012

04/12/2012

18/12/2012

01/01/2013

15/01/2013

29/01/2013

12/02/2013

26/02/2013

12/03/2013

26/03/2013

09/04/2013

23/04/2013

07/05/2013

21/05/2013

04/06/2013

18/06/2013

02/07/2013

S&P Cons Stap / S&P 500

10-year US Treasury yield (Inverted)

July 2013

33

16/07/2013

While many of these are (quite rightly) heavily owned already, an alternative beneficiary of lower bond yields is the Utilities sector. The next chart shows the S&P 500 Utilities price relative versus the 10-year Treasury yield interesting that Utilities are close to their post-crisis low.
S&P 500 Utilities price relative v. US 10-yr Treasury yield
0.18 1.00

0.17

1.50

0.16 2.00 0.15 2.50 0.14 3.00 0.13 3.50 0.12

Source: Monument Securities

0.11

4.00

0.10

4.50

The utilities stock which has grabbed my attention is National Grid in the UK.
National Grid price relative v. UK 10-yr gilt yield
0.25 1.00 0.24

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

S&P 500 Utilities / S&P 500

US 10-yr Treasury yield (Inverted)

1.50

0.23 2.00 0.22 2.50

0.21

0.20

3.00

Source: Monument Securities

0.19 3.50 0.18 4.00

0.17

0.16

4.50

01/03/2010

01/04/2010

01/05/2010

01/06/2010

01/07/2010

01/08/2010

01/09/2010

01/10/2010

01/11/2010

01/12/2010

01/01/2011

01/02/2011

01/03/2011

01/04/2011

01/05/2011

01/06/2011

01/07/2011

01/08/2011

01/09/2011

01/10/2011

01/11/2011

01/12/2011

01/01/2012

01/02/2012

01/03/2012

01/04/2012

01/05/2012

01/06/2012

01/07/2012

01/08/2012

01/09/2012

01/10/2012

01/11/2012

01/12/2012

01/01/2013

01/02/2013

01/03/2013

01/04/2013

01/05/2013

01/06/2013

National Grid / FTSE All-Share

UK 10-year gilt yield (Inverted)

The company confirmed its new dividend policy earlier this year (at least in line with RPI for foreseeable future) and offers a yield of 5.9%. If we are entering a more difficult macro period, National Grid has the advantage of having recently (year to March 2013) reached regulatory approval covering 80% of its asset base for the next eight years in the UK. That asset base should also see solid growth (6-7%p.a.?) in the coming years. Management was upbeat on the outlook when it announced FY2013 results back in May and there are potential catalysts on 29 July 2013 (IMS) and 6 August 2013 (Investor seminar). It has zero exposure to emerging markets, with activities concentrated in the UK and US.

July 2013

34

01/07/2013

Back to the world tour...

Europe: stabilising but depressed


In Europe, the good news is signs of improvement in some of the weakest major economies, notably Spain. Bad news includes continued signs of stalling in the German manufacturing sector and renewed signs of structural problems with the Euro project itself. Even the banking crisis in Cyprus did not seriously disrupt what, until recently, had been a period of relative calm and declining bond yields in the Eurozone. You knew it wasnt going to last, although its calming down again...temporarily?
Portugal 10-year government bond yield
12.0

11.0

10.0

9.0

Source: Monument Securities

8.0

7.0

6.0

5.0

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

Besides the fallout in the JGB market and the debate over Fed tapering, weve had a renewed spate of Euro-specific problems, e.g. the scandal involving illegal payments to Spains Prime Minister, a political crisis in Portugal, a debt downgrade for Italy and renewed concerns about Greek insolvency. The question is whether we can get to the other side of the German election on 22 September 2013 without any major incidents undermining the markets. Even if we do, the can of worms will probably be subject to greater scrutiny in the tail end of the year. In the equity market, the close correlation between the Euro Stoxx 50 and the Citi Economic Surprise Index for the Eurozone broke down between January and early-June this year, but has re-connected of late.
Euro Stoxx 50 v. Citi Economic Surprise Index - Eurozone
3300 100 80 3100 60 40 20 2700 0 -20 -40 2300 -60 -80 2100 -100 1900 -120

2900

May-13

Jul-13

Source: Citibank, Monument Securities

2500

Apr-11

Apr-11

Apr-12

Apr-13

Feb-11

Sep-11

Feb-12

Sep-12

Sep-12

Feb-13

Feb-13

Apr-13

Jun-11

Jun-11

Jun-12

Jun-13

Jun-13

Jul-11

Jul-12

Jul-12

Mar-11

Mar-12

Mar-12

May-11

May-12

May-12

Mar-13

Dec-11

Dec-11

Aug-11

Aug-11

Aug-12

Dec-12

Oct-11

Oct-11

Oct-12

Jan-11

Jan-11

Jan-12

Nov-11

Nov-12

Nov-12

Jan-13

Euro Stoxx 50

CESI Eurozone

July 2013

35

May-13

Jul-13

In terms of economic outlook, the Composite PMI for Europe has been ticking upwards for the last three

Source: Markit.com, Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
30 35 40 45 50 55 60 65

-40.0 -5.0 0.0

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

4600000

4700000

4800000

4900000

5000000

5100000

5200000

5300000

5400000

May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-08 May-08 Feb-08 Nov-07 Aug-07 May-07 Feb-07 Nov-06 Aug-06 May-06 Feb-06 Nov-05 Aug-05

May-05

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

months, printing at 50.4 for July 2013.

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Consumer confidence is recovering from low levels.

Sep-10

Nov-10

But there is still no credit growth in the household sector.

Eurozone Consumer Confidence

Consumer credit outstanding (Eur m)

Eurozone Composite PMI

Eurozone consumer credit

36

Jan-11

Mar-11

May-11

Jul-11

Sep-11

yoy %

Nov-11

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

0.0%

1.0%

2.0%

5.0%

6.0%

3.0%

4.0%

-1.0%

Last week, the ECB cut haircuts and minimum ratings on ABS collateral which was merely indicative of how weak lending is within the Eurozone. It looks like a dead cat bounce in the Spanish economy... The June manufacturing PMI for Spain printed at 50.0 (up from 48.1) after 25 months of contraction. New orders moved above 50.0 for the first time since April 2011 due to stronger demand from overseas markets. The latest export statistics show some improvement from a weak 2012 comparison.
Spain: exports (yoy %)
40%

30%

20%

10%

Source: Monument Securities

0%

-10%

-20%

-30%

Sep-99

Sep-00

Sep-01

Sep-02

Sep-03

Sep-04

Sep-05

Sep-06

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

May-99

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

May-11

May-12

Jan-13

There are tentative signs of an improvement in industrial production.


Spain: Industrial production 3m MA (yoy %)
10%

5%

0%

-5%

-10%

May-13 May-13

Source: Monument Securities

-15%

-20%

-25%

-30%

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

July 2013

37

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

There are also signs of some improvement in the consumer sector.


Spain: Consumer confidence v. retail sales
0 -5 -10 -15 -20 -25 -30 -35 -40 -45 -50 8% 6% 4% 2% 0% -2%

Source: Monument Securities

-4% -6% -8% -10% -12%

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

Consumer confidence

Retail sales 3m MA (yoy %)

So Spain has bottomed, at least temporarily. The latest Markit survey on the Spanish manufacturing sector emphasised a continued reluctance to hold inventories through the manufacturing chain. Consequently, if this recovery can be sustained for any length of time, it might be magnified by restocking. However, it pays not too look too hard at its banking sector delinquent loans are on a gently rising trend again.
Spain: Bad loans (% of total)
12.0

10.0

8.0

6.0

May-13

Source: Monument Securities

4.0

2.0

0.0

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

July 2013

38

May-13

There is still very little sign of life in the share price of Spains weakest major bank, Banco Popular, or its slightly better off rival.
Banco Popular & Banco Santander (Euros)
22 20 18 16 14 12

Source: Monument Securities

10 8 6 4 2

In Portugal, the Prime Minister is toughing it out amid the political turmoil. The markets might take fright if the government collapses, although a new coalition (led by the Socialists) is unlikely to want to exit the Eurozone. The other risk is the growing unrest amongst the Portuguese people which led to the recent mass protests. Not surprising given the unemployment situation.
Portugal unemployment rate (%)
18

16

14

12

10

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

Banco Popular

Banco Santander

Source: Monument Securities

2 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Portugal was the Troikas role model problem child, but there are hurdles looming on the horizon. Portugal has enough bailout money to see it through to May 2014. With government debt amounting to about 8% of GDP needing to be refinanced next year, the total funding requirement will be 12-13%. Portuguese GDP growth has been negative since Q1 2011. The 4.0% year-on-year fall in Q1 2013 was the weakest of the lot.

July 2013

39

However, that should be the trough. The EC Economic Sentiment Index continues to recover and industrial

Source: Monument Securities

Source: Monument Securities

Source: Monument Securities

July 2013
100 110 120
-5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0

60

70

80

90

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13
0 5 10 15 -5 -20 -15 -10

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

production has bounced back into positive territory.

Jan-09

Mar-09

EC Economic Sentiment Index

May-09

Portugal: GDP growth (yoy %)

Portugal: Retail sales (yoy %)

Portugal: EC Economic Sentiment Index v. Industrial production

Thus far, the recovery in retail sales is confined to a slowdown in the rate of decline.

40
Industrial production (yoy %)

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

Q1 2000 Q2 2000 Q3 2000 Q4 2000 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Q1 2003 Q2 2003 Q3 2003 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013

Exports have surprised on the downside recently and are in negative year-on-year territory together with

Source: Monument Securities

Source: Markit.com, Monument Securities

Source: Monument Securities

July 2013
-40 10 20 0 -30 -20 -10 30 40 -3.0 0.0 1.0 2.0 3.0 4.0 5.0 -2.0 -1.0

-50

-40

-30

-20

-10

10

20

30

40

Jan-99 May-06 Jul-06 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 May-01

Mar-06

Jan-01

May-99

Sep-99

Jan-00

May-00

Sep-00

Jan-01

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

export orders for the manufacturing sector.

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Germany: Manufacturing orders (yoy %)

Manufacturing PMI: Germany - Eurozone

Germany: Export manfucturing orders v. exports (yoy %)

The problem with Germany is the weakness in the manufacturing sector as mentioned above.

The German manufacturing PMI is now slightly below the average for the Eurozone as a whole.

Export manufacturing orders (yoy %)

41

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Exports (yoy %)

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

May-13

The recent turmoil began, appropriately, in Japan which is at the cutting edge of the battle against deflation

Source: Monument Securities

Source: Monument Securities

July 2013
0.90 0.95 1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40 -6.0% 0.0% 2.0% 4.0% 6.0% -4.0% -2.0%

Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13

Siemens against the DAX.

Japan: bright spot (for now)

Siemens: price relative to DAX

Germany: Real retail sales 3m MA (yoy %)

- and burdened as it is with the highest public debt and negative demographics.

Domestic demand remains more robust. German retail sales are in positive territory.

42

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

The 2% inflation target is clearly incompatible with sub-1% bond yields and a significant rise in government bond yields is incompatible with the Japanese governments finances.
JGB 10-year yield (%)
1.00

0.90

0.80

0.70

Source: Monument Securities

0.60

0.50

0.40

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

We are stuck in a kind of no-mans land, which is probably about the best place that we can be. The chances are that something is likely to go very wrong at some point with the Japanese economy or the Yen. While things are far from resolved, at least the turbulence in the bond and forex markets has subsided. In May, Japanese industrial production rose 2.0% month-on-month, while the year-on-year decline has almost unwound.
Japan: Industrial production (yoy %)
30%

20%

10%

0%

May-13

Jul-13

Source: Monument Securities

-10%

-20%

-30%

-40%

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

July 2013

43

May-13

Both the manufacturing PMI and the Tankan survey for large manufacturing enterprises have crossed into expansionary territory, above 50 and zero, respectively.
Japan: Manufacturing PMI v. Tankan
60 30 20 55 10 50 0

Source: Markit.com, Monument Securities

45

-10 -20

40

-30 -40 -50

35

30 -60 25 -70

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

Manufacturing PMI

Tankan

On a positive note, the Markit/JMMA report on the June PMI reported: A key driver of the latest improvement in the headline index was a marked and accelerated increase in volumes of new orders. Growth was the best for three years, with latest data implying that demand from domestic sources was a key driver of sales wins. This obviously augurs well for momentum in the domestic economy in the next few months. The index for activity in the retail trade is rebounding.

Japan: Retail trade (yoy %)


12.0 10.0 8.0 6.0 4.0 2.0

May-13

Source: Monument Securities

0.0 -2.0 -4.0 -6.0 -8.0 -10.0

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Sep-12

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

May-07

May-08

May-09

May-10

May-11

May-12

Mar-13

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Jan-13

July 2013

44

May-13

The G20 sanctioned devaluation of the Yen (although some of the BRICS nations were privately less im-

For the time being, the short-term travelling for Japan has the potential to be considerably better than the

eventual arriving. This suggests that there is probably another leg up in what was THE crowded trade for

Source: Monument Securities

Source: Monument Securities

July 2013
-50 10 20 30 40 0 -40 -30 -20 -10 50 10000 12000 14000 16000 4000 6000 8000

much of this year.


Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13

pressed) is currently providing a boost to exports.

Japan exports (yoy %)

Nikkei 225

45

Dec-08 Jan-09 Feb-09 Mar09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Mar-10 Apr-10 May-10 Jun10 Jul-10 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 May-13 Jun-13 Jul-13

Inflationary Deflation: endgame update


Brief summary: Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed worlds currencies will have to bear the brunt of the adjustment. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new basket currency is likely to replace the dollar as the worlds reserve currency. The Inflationary Deflation paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold. In the last report, we analysed the negative consequences of QE on the (oh so vital) liquidity of the shadow banking system. In particular, the way in which QE disrupts the flow of high quality collateral by silo-ing Treasury and MBS securities. The IMF, Bank for International Settlements, Bank of England and US Treasury Borrowing Advisory Committee (TBAC) have published reports in recent months warning of the risks. The TBAC identified the gross shortage of high quality collateral US$4.6-11.2 trillion - under stressed market conditions.

Its abundantly clear that this is where (massive) systemic risk lies...we can only hope that we dont return to stressed market conditions for as long as possible. The Federal Reserve is acutely aware of these risks as well demonstrate - but (no surprise) doesnt identify them specifically. The closest we got is probably the speech on 28 June 2013 by Fed governor, Jeremy Stein, who commented (my emphasis): Although asset purchases also bring with them various costs and risks - and I have been particularly concerned about risks relating to financial stability - thus far I would judge that they have passed the cost-benefit test. July 2013

Source: TBAC

46

Most people have failed to notice, but recent developments have cast light on the collateral issue. Under the provisions of the Dodd-Frank Act, many OTC derivatives are migrating to exchanges in three stages during 2013. This is leading to increased volumes of collateral needing to be lodged with central counterparties (CCPs). The first stage was implemented on 11 March 2013, the second on 10 June 2013, with the third due on 9 September 2013. A clear signal of stress in the shadow banking system is a surge in fails-to-deliver, which reflects a shortage in the availability of high quality collateral. The first two stages of the migration to CCPs, in March and June, resulted in spikes in fails in US Treasury repos.

In March, the collateral shortage was particularly severe in the benchmark 10-year Treasury which traded at the special 3% penalty rate in the repo market. This was Zero Hedges Tyler Durden on 15 March 2013: If the ongoing repo super-specialness persists, beware: as it will be the first time since Lehman that cracks have appeared in the very fragile shadow banking system...the critical nexus that allows Dealers to transform reserves into risk-asset purchasing dry powder. The same thing happened in June - this from Bloomberg on 4 June 2013... A shortage of U.S. Treasury 10-year notes in the government debt funding market has traders willing to pay to borrow the securities in exchange for loaning cash for the most actively traded maturity. The overnight repurchase agreement, or repo rate, for the 1.75 percent note due in May 2023 opened at negative 2.95 percent and closed at negative 3 percent at 10 a.m. New York time ...and stress was apparent again earlier this month as repo rates went negative in 3 and 10-years:

Source: Alhambra Investment Partners

July 2013

47

In a recent post on the Alhambra Investment Partners website, Jeff Snider observed a change in the patterns of Fed purchases of Treasuries in its QE programme. Noting that repo counterparties prefer the most recently auctioned (i.e. on the run or OTR) Treasuries, he pointed out that the Fed had bought 25% of the OTR 5-year issue in January 2013, 13% of the next issue, then under 5% and zero of the last issue. In the 10-year, the Fed bought 18% of the January 2013 issue, then 8% followed by zero. Snider commented: What the SOMA (System Open Market Account) data above suggests, and highly so, is that the Fed recognizes the role of QE in removing OTR collateral. Why else would they start by purchasing relatively high proportions of OTRs and then drop to nothing, or nearly nothing, after the repo markets went so special? It seems pretty clear to me that the Fed noticed the repo warnings and acted, thus confirming, operationally, what we have suspected about QE...Bottom line is I believe collateralized lending markets, the marginal source of effective liquidity post-2007, are short of collateral for numerous reasons, leading to all manner of side-effects. On 17 July 2013, the SEC took a more active role in the repo market when it asked money market funds to review procedures should there be defaults in the repo market. According to Reuters: The U.S. Securities and Exchange Commission on July 17 quietly issued new guidance to money funds that spells out the risks they could face if borrowers in the tri-party repurchase market collapse...In a four-page document, the SEC urges funds and advisers to review master repurchase agreement documentation to see if there are any procedures to handle defaults, and if necessary, prepare draft templates in advance. It also calls for funds to consider the operational aspects of managing a repo, and to contemplate whether there are any legal issues that could arise in the event of a repo default. The phrase Watch this space is not going to lose relevance for an extended period when it comes to collateral and shadow banking. Another market which is a focal point of the ongoing crisis is gold. We highlighted last time how gold had moved into backwardation in the futures market, i.e. near month future lower than spot, in April 2013. This remains the case and as Sandeep Jaitly commented in his July 2013 Gold Basis Service: Not only has the backwardation remained in gold, but it has escalated July 2013

Source: Zero Hedge, ICAP

48

The backwardation in gold effectively spread from the futures market to the lending market in London when GOFO (Gold Forward Offered Rate) went negative on 8 July 2013.
Gold Forward Offered Rate (GOFO)
0.50

0.40

0.30

Source: LBMA, Monument Securities

0.20

0.10

0.00

-0.10

-0.20

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

GOFO is the interest rate to borrow dollars using gold as collateral. If you are a gold holder, a negative GOFO means that the market is prepared to lend you dollars AND pay interest in return for use of your gold for the duration of the loan. As with backwardation in futures, it implies that there is stress in the system with regard to the availability of physical gold in this case 400oz. London Good Delivery bars on the LBMA. This is only the fourth occasion since 1999 when GOFO has been negative. On the other three occasions, the negative rates lasted two days and coincided closely with lows in the gold price (1999, 2001 and 2008). Weve been shouting from the rooftops since 2006-7 that the gold market is a gigantic fractional reserve system consisting of a vast quantity of paper claims to gold bullion and a much smaller inventory of actual bullion. Thanks to Ned Naylor-Leyland of Cheviot Asset Management for pointing me in the direction of the Reserve Bank of Indias January 2013 report Report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans by NBFCs. On page 58 is the following data sourced from the CPM Gold Yearbook 2011: Gold Futures and OTC Market Vs Physical Market for Gold (million ounces)

Instrument Physical market Futures & Options ET vol. LBMA (OTC) clearing volume Total
Source RBI

May-13

Jul-13

2010 120.8 6438.8 4727.7 11287.3

July 2013

49

In the words of the RBI with my emphasis: the traded amount of paper linked to gold exceeds by far the actual supply of physical gold: the volume on the London Bullion Market Association (LBMA) OTC market and the major Futures and Options Exchanges was OVER 92 TIMES that of the underlying Physical Market. The CFTCs Bank Participation Report on trader positions on COMEX for June 2013 showed that the US bullion banks had moved to a net long position of nearly 30,000 contracts (3 million oz.) from a huge net short position of 106,000 contracts (10.6 million oz.) when gold peaked in October 2012 an overall swing of about $20 billion in fiat terms into a declining market. The July 2013 data shows that the US bullion banks increased their net long position to almost 45,000 contracts, while speculators (hedge funds?) increased shorts and reduced longs. Are the banks (finally) getting ready to squeeze the funds, or are they preparing for another big raid? We hope the latter given that the apparent depletion of gold inventory in the vaults continues. Below is the data for COMEX registered vaults.

COMEX Gold inventory (m oz.)


12.0

11.0

10.0

Source: COMEX, Monument Securities

9.0

8.0

7.0

6.0

Sep-12

Feb-13

Apr-13

Jun-13

Jul-12

Mar-13

Aug-12

Dec-12

Oct-12

Nov-12

Jan-13

Furthermore, Rabobank has followed in the footsteps of ABN Amro in suspending delivery of physical bullion to its clients. With rumours circulating that a major bullion bank is preparing to change its delivery agreements, the implication being that it too will suspend or curtail physical delivery, we are wondering whether the breakdown in the physical versus paper gold markets is approaching...leading to price discovery for physical gold itself.

July 2013

50

May-13

Jul-13

Slide away (slides from recent corporate presentations)


Latest from Daimler on the auto market

Volume and price trends for SKF

Source: SKF

July 2013

51

Applied Materials on mobile growth

KPCB on mobile share of internet traffic

July 2013

52

Orange on mobile data growth in Europe

Teradata on the data warehouse market

July 2013

53

Mastercard predicting strong growth

Syngentas update on crop protection market trends

July 2013

54

...and predicting a stronger H2 2013

We have a yield problem

July 2013

55

United Technologies on its order book

Lockheed Martin updating its 2013 outlook

July 2013

56

Pricing helping Philip Morris while volumes remain under pressure

July 2013

57

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July 2013

58